Leveraged Recapitalization and Exchange Offers

Prof. Ian Giddy

New York University

Leveraged Recapitalization Strategy where a company takes on significant additional debt with the purpose of paying a large dividend (or repurchasing shares) z Result is a far more leveraged company -- usually in excess of the "optimal" debt capacity z After the large dividend has been paid, the market value of the shares will drop.
z
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Corporate Financial Restructuring 2

Leveraged Recapitalizations
z

Motivations:
Defensive Proactive Ownership

transition/liquidity

Which produces what value?

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Corporate Financial Restructuring 3

Sealed Air
1.

2.

3.

Why did Sealed Air undertake a leverage recapitalization? Do you think that it was a good idea? For whom? Dunphy was an MBA (HBS class of '56), shouldn't any self-respecting MBA be able to find a way to spend several hundred million dollars? How much value was created? Where did it come from?
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Copyright 2004 Ian H. Giddy

Exchange Offers Give one or more classes of claimholders the option to trade their holdings for a different class of securities of the firm. z Typical examples are allowing common shareholders to exchange their shares for bonds or preferred stock, z Or vice-versa z Motivations?
z
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Exchange Offers-Effect Depends On:

z z z z z z

Leverage increasing or decreasing Implied increases or decreases in future operating cash flows Implied undervaluation or overvaluation of common stock Increase or decrease in management share ownership Increase or decrease in management control over cash usage Positive or negative signalling effects.
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Copyright 2004 Ian H. Giddy

Exchange Offers
Right to exchange from: Common stock Common stock Preferred stock Preferred stock Debt Debt Preferred stock Debt Debt to: Debt Preferred stock Debt Income bonds Private equity Common stock (forced) Common stock Preferred stock Common stock Net return

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Exchange Offers
Right to exchange from: Common stock Common stock Preferred stock Preferred stock Debt Debt Preferred stock Debt Debt to: Debt Preferred stock Debt Income bonds Private equity Common stock (forced) Common stock Preferred stock Common stock Net return +14% +8.2% +2.2% +2.2% -0.9% -2.1% -2.6% -7.7% -9.9%

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Dual-Class Recapitalizations The creation of two classes of common stock, one of which has limited voting rights but typically a preferential claim on the company's cash flows z Must be approved by shareholders z May create entrenched management
z

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Truck Toys

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Restructuring Truck Toys

z

Evaluate the leveraged recap:

1. 2. 3.

4.

What would be the value of what outside investors received? Of what management received? What would be the percentage of ownership held by management after the recapitalization? How receptive do you think senior and subordinated investors would be to this? Develop a pro-forma balance sheet and interest coverage analysis, after the recap, assuming senior debt pays 12% and subordinated debt pays 15%. Would the company be able to pay down its subordinated debt? How?

Which of the three alternatives might make sense? How would they work?

Copyright 2004 Ian H. Giddy

Corporate Financial Restructuring 11

Sealed Air
1.

2.

3.

Why did Sealed Air undertake a leverage recapitalization? Do you think that it was a good idea? For whom? Dunphy was an MBA (HBS class of '56), shouldn't any self-respecting MBA be able to find a way to spend several hundred million dollars? How much value was created? Where did it come from?
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Copyright 2004 Ian H. Giddy

Organizational Effects of Leverage

Too little leverage -waste of resources inside organization Inefficiency Too much scrap, capital expend., R&D

Too much leverage

-pushed to generate cash at the expense of value -too little inventory -not enough credit for customers - skimping on quality, capital expend, R&D
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Copyright 2004 Ian H. Giddy

Sealed Air's Changing Competitive Environment They had traditionally neglected manufacturing in favor of marketing. able to do this because of a lack of competition z About a year before the recap, they launched a program of manufacturing excellence. z When this worked, SA had cash and debt capacity
z
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Sealed Air: Before and After

April 1989

December 1989

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Post-Recap Balance Sheet

(dollars in millions) 1989 Operating Data: Net Sales Gross Profit Gross Profit Margin EBITDA EBITDA Margin Interest Expense Preferred Dividends Capital Expenditures Balance Sheet Data: Cash / Short-term Inve Total Assets Total Debt Preferred Stock Stockholders' Equity Total Capitalization 385 135 34.9% 70 18.2% 32 0 14 2002 (1) 3,204 1,058 33.0% 689 21.5% 65 54 92

24 229 311 0 (161) 151

127 4,261 923 1,327 810 3,060

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The Financial Restructuring? What about the negative net worth? z How did the the Special Dividend work? z Effect of the recap on firm value and performance? z Change in shareholder value over the years following the recap?
z

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Copyright 2004 Ian H. Giddy

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Company Overview

The world leader in food, protective and specialty packaging materials and systems including: Cryovac brand of food and specialty packaging products Instapak , Bubble Wrap and Jiffy brands of protective packaging and other products Plants - over 105 manufacturing facilities and operations in 48 countries 2002 sales - $3.2 billion 2002 EBITDA - $689 million (excludes asbestos settlement charges) Approximately 18,000 employees

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Company Overview
Food Packaging Protective Packaging

2002 Sales ($mm) $1,958 (61%) $1,246 (39%) __________________________________________________________________________________________ Packaging Fresh meat, smoked and processed Cushioning, blocking, bracing, Applications meat, poultry, cheese, fish, produce, surface protection, presentation bread, fluid food __________________________________________________________________________________________ Major Shrink bags, shrink films, non-shrink Air cellular cushioning, polyurethane Products films, absorbent pads, rigid containers, foam, shrink and non-shrink films, packaging systems protective and durable mailers, suspension and retention packaging, polyolefin foams,packaging systems __________________________________________________________________________________________ Product Superior package integrity Superior protection from Benefits Extended product shelf life shock, vibration, and abrasion Superior shrink, clarity and gloss Superior shrink, clarity and gloss __________________________________________________________________________________________ Competitors (US/EU) Pechiney, Bemis, Bemis, Pactiv, Other product alternatives Other product alternatives

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Company Overview

Geographic Sales Breakdown

Europe 26%

7% Latin America
Australia / New Zealand 6%

3% Asia

58%
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North America

Note: Results for the twelve months ending December 31, 2002

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Company Overview
Air Cellular Cushioning

Powerful Brands Bubble Wrap Cryovac Instapak Jiffy

Cushioned & Durable Mailers

Vacuum Shrink Packaging

Foam -inplace

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Company Overview
Proven Record of Business Development

196 0
Bubble Wrap Air Cellular

197 0
Surface Protection PE Foam

198 0
Padded & Durable Mailers

199 0
Inflatable Void Fill

200 0
High Performance Food Packaging

Protective Mailers

Foam-in-place Cushions

Absorbent Pads

Suspension/ Retention Packaging

Niche non-barrier Food Packaging

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Financial Overview

Highlights: 1998 through 2002

Net sales have grown at a 3.4% CAGR since 1998

Gross margins of 32% - 35% EBITDA margins

EBITDA margins of 20% - 23% (5-10% higher than average packaging company)

Five year average FCF of $251 million per year

2002 free cash flow of $220 million - $250 million

Net reduction of debt and preferred stock, net of cash, of $945 million from March 31, 1998 through December 31, 2002
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Financial Overview
Historical Financials - Then and Now
(dollars in millions) 1989 Operating Data: Net Sales Gross Profit Gross Profit Margin EBITDA EBITDA Margin Interest Expense Preferred Dividends Capital Expenditures 385 135 34.9% 70 18.2% 32 0 14 2002 (1) 3,204 1,058 33.0% 689 21.5% 65 54 92

Balance Sheet Data: 24 127 Cash / Short-term Inve Total Assets 229 4,261 Total Debt 311 923 Preferred Stock 0 1,327 Stockholders' Equity (161) 810 Total Capitalization Note: (1) Excludes: asbestos settlement151 and related costs; 3,060 restructuring costs;

asset impairments; merger transaction costs; and other unusual items.

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Liquidity: Debt Distribution

Sealed Air Corporation

$3,500 $3,000

$ Millions

$2,500 $2,000 $1,500 $1,000 $500 $0

'99 '98 '99 '00 '00 '99 '98 '99 '00 '98 '00 '01 '98 '01 '01 '01 '02 '02 '02 1Q 3Q 2Q 4Q 2Q 1Q 4Q 3Q 3Q 1Q 4Q 1Q 2Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q '02

364-Day Global Revolver US Receivable Securitization

5-Year Global Revolver US Senior Notes

ANZ 3-Year Revolver Eurobonds

Other Bank Debt Convertible Preferred

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Copyright 2004 Ian H. Giddy

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Contact Info
Ian H. Giddy NYU Stern School of Business Tel 212-998-0426; Fax 212-995-4233 Ian.giddy@nyu.edu http://giddy.org

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